Central Bank Digital Currency

We’re spending more time and money on the internet than ever, and monetary systems that predate the digital era have sometimes struggled to adapt. Complex payment processing and banking schemes have evolved to facilitate e-commerce, but many governments and financial institutions have decided that the time has come for a fully modernized system.

The proposed solution: Central Bank Digital Currencies, which could herald a radical change in the way we handle electronic purchases and fund transfers in the future. What is a Central Bank Digital Currency, and what effect might these currencies have on e-commerce merchants and other businesses?

1. What is a Central Bank Digital Currency?
2. What's the Difference between Central Bank Digital Currencies and Cryptocurrencies?
3. Are Central Bank Digital Currencies Secure?
4. What is the Purpose of a Central Bank Digital Currency?
5. Where are Central Bank Digital Currencies Currently in Use?
6. Conclusion

While only a few countries have actually launched a Central Bank Digital Currency (CBDC) program so far, there are about 100 currently in the development stage. That’s more than half of all central banks on the planet, including major economies like China, France, and Canada.

In November 2022, the Federal Reserve Bank announced its plans to launch a proof-of-concept pilot program for a CBDC in the United States. Several of the largest banks in the US will be participating in this program, including BNY Mellon, Citibank, Mastercard, and Wells Fargo. Although a full-scale launch may yet be some ways off, this is a strong indicator that it’s only a matter of time before the digital dollar is here.

For the businesses who deal with digital payments day in and day out, the big question is just how CBCDs are going to work and what the unintended consequences might be.

Central Bank Digital Currencies are digital assets, issued by a country’s central bank, with a cash value that is pegged to that country’s fiat currency.

In other words, a CBDC would be a token that would exist and be traded entirely online, not a representation of a physical unit of currency held by a bank somewhere. The central bank that issues it would hold it to the same regulatory standards and maintain parity between the values of each form of currency.

There are two types of CBDCs:

• Wholesale CBDCs, which are used by financial institutions for deposits and interbank transfers.
• Retail CBDCs, which are used by businesses and consumers. These can either be token-based, which can be traded anonymously, or account-based, which are tied to specific identities.

Both types may be issued by the same central bank.

Most cryptocurrencies are designed to be decentralized, which means they aren’t subject to the authority of any single issuing body. The defining feature of Central Bank Digital Currencies is that they are issued and regulated by a single country’s central bank.

Beyond that, there are some other key differences. While some cryptocurrencies are intended to hold a fixed value, many are freely traded as investments, leading to highly unstable valuation.

CBCDs hold the same value as their fiat currency and are issued to be spent freely, not held as a speculative investment.

It is true that cryptocurrencies have inspired many CBDC programs, and have served as a model for possible technological implementations. However, the centralized nature of CBDCs means that they will not necessarily have to use blockchain technology, as most cryptocurrencies do. There is also no guarantee that any given CBDC will allow anonymous transactions.

CBDCs are being designed with built-in security features: encryption keys for token-based systems, identity verification protocols for account-based ones.

Cybercriminals always follow the money, and it is inevitable that they will attempt to hack and exploit any successful CBDC system. There is also a high likelihood that any CBDC that uses anonymous tokens could get used for money laundering and other offenses.

No digital currency can claim to be completely fraud-proof, but CBDCs are still new enough that we have yet to see them tested. As threats develop, we may see refinements to CBDC security protocols—just as we have seen with the credit card system in recent decades.

The primary purpose of Central Bank Digital Currencies is to facilitate accessible and convenient digital payments while minimizing the risk, complexity, and costs of the current financial system.

CBDCs also give central banks a greater degree of control over policies and regulations that affect the digital economy, and can reduce the costs of cross-border transactions and peer-to-peer fund transfers.

As an alternative to cryptocurrencies, CBDCs can offer security and stability while still preserving desirable features such as privacy and interoperability.

Individuals without bank accounts, a growing consumer segment, can use CBDCs for electronic payments instead of being stuck using private, for-profit apps.

Right now, the only fully operational Central Bank Digital Currencies are in the Caribbean and Africa: The Bahamas’ Sand Dollar, which debuted in October 2020, and Nigeria’s eNaira, which launched a year later.

Many other countries are in the process of launching pilot programs, while more are still researching the concept. Merchants and consumers won’t be involved in the Fed’s new pilot program, which is intended to root out any potential technical or legal issues as banks transfer CBDC tokens using simulated central bank reserves.

Further testing—and support from a broader range of lawmakers—is likely to be required before a public launch is imminent.

Conclusion

For merchants, CBDCs offer some promise as well as uncertainty. The existing systems for e-commerce payments, most of them built on top of the credit card payment framework, are constantly targeted for fraud and abuse. Alternative systems may appeal to some consumers, but it can be burdensome to maintain secure and user-friendly integrations with a long list of proprietary payment platforms.

CBDCs, when they arrive in force, will allow merchants and consumers to make a fresh start with a new system that won’t be subject to the ups and downs of private fintechs or unregulated blockchains. However, there’s still a lot we don’t know about how CBDCs will work at the retail level—including how fraud and disputes will be resolved. For now, we can remain hopeful that CBDCs will offer merchants more opportunities than challenges.

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